Alternative Trader

Alternative Trader

Entrepreneurs by Jean Gruss | Editor/Lee-Collier

Entrepreneur James Lennane has spent millions of dollars to build a stock-trading platform. With the stock market on the rebound, his time may finally have arrived.

It's two o'clock on a recent Monday afternoon and James Lennane is running late.

He greets a visitor wearing a bandage that covers the lower left side of his face, apologizing for the skin-cancer surgery that took longer than expected.

Lennane won't accept sympathy. "This is my 55th surgery," he says with a shrug and a wave of his hand while slipping off his sneakers.

It's quickly apparent that this is not a man who is easily defeated.

That's a good thing, because the Naples-based entrepreneur is taking on two of the most powerful forces in the world: the U.S. securities industry and the omnipotent regulators who oversee it.

His company, ex24, is the only online exchange where ordinary investors can buy and sell shares from each other without a broker. The business model mirrors eBay, where buyers and sellers meet to exchange goods online.

Of course, his trading system is heresy in the brokerage world. This helps explain why he's only got a few thousand customers after spending $9 million to build the ex24.com Web site and waging battles with regulators in Washington D.C. since he started the business in 1998.

But his efforts may yet pay off in a big way. The plan is to build a critical mass of 20,000 to 50,000 customers and partner with some of the leading Internet companies to challenge well-established exchanges such as the Nasdaq.

It won't be easy. Lennane says he's had discussions with Google and eBay about the business. He says Google wasn't interested and eBay was concerned about the burden of government oversight.

Lennane is undeterred. He's a successful entrepreneur who moved to Naples after he sold his newspaper publishing software company, System Integrators, for $125 million in 1989. He now owns a private-jet company in Naples called Continental Aviation Services and a produce-distribution company near Sacramento, Calif.

Although he's already spent $9 million of his own money on ex24, he's contemplating investing another $2 million to boost the number of customers. Already, a marketing campaign on Google's Web site is bringing in half a dozen new customers a day.

With the stock market rebounding and the technology bust a distant nightmare, ex24's time may finally be at hand.

Trade amongst yourselves

Lennane started dreaming about a broker-less exchange years ago when System Integrators was listed on the New York Stock Exchange. Why couldn't ordinary investors trade his company's stock amongst themselves without a broker taking a commission?

He got his chance in 1998, when regulators announced they would let entrepreneurs create what's called alternative-trading systems (ATS). "The ATS was my dream," Lennane says. At the time, regulators welcomed competition that promised to make markets more efficient.

However, regulators from the National Association of Securities Dealers (NASD) and the Securities and Exchange Commission (SEC) had not spelled out the rules and Lennane says they were unprepared for individual entrepreneurs to apply to operate an ATS.

Every time Lennane satisfied one requirement, they demanded another. "They kept raising the bar," Lennane says. For example, just as they were ready to launch, regulators demanded the firm belong to the Depository Trust & Clearing Corp., which clears millions of stock and bond trades.

Because of repeated delays, Lennane says it took five years to get NASD's approval. By 2003, just as the stock market was recovering from the bust, Lennane says he was ready to launch his trading system.

But to jump-start the system, Lennane had to provide new customers with a way to buy and sell stocks. Until the time when enough customers could sell to each other, Lennane had to be the buyer and seller on the other side of the customer's trade.

To facilitate the trades, the SEC told Lennane that he had to qualify as a market maker under the same rules as the tech-dominated Nasdaq exchange. A market maker is a company that maintains order in the buying and selling of stocks and steps in when buyers or sellers don't honor their side of the deal. But being a market maker requires millions of dollars in capital, something small entrepreneurs like Lennane don't have to put at risk.

Lennane battled the SEC, but he didn't win. He recalls debating an SEC regulator one day in a conference call, arguing that the ATS rules didn't spell out the definition of a market maker. "These are my rules," the regulator told Lennane.

Because ex24 could not become a Nasdaq-style market maker, the SEC limited the firm to handling trades of 99 shares or less. And because ex24 only has about 2,000 customers, Lennane is frequently the one on the other side of a buy-or-sell trade. "All the money in the world won't move the guys in Washington," says a visibly exasperated Lennane.

Ex24 finally started operations as an ATS in April 2004, six years after Lennane started. But even at $2 a trade, it's been a tough sell.

Becoming a discount broker

To attract more customers, Lennane decided ex24 should become a discount broker. With the help of Anthony Link, the company chief operating officer and veteran of discount brokerage TD Waterhouse, ex24 started selling stocks just like other discount brokers such as Ameritrade or Charles Schwab.

But because ex24 had received approval to be a self-clearing broker in its quest to build a trading system, it could process trades more cheaply than its discount-broker competitors. Settling trades through an outside firm can cost as much as $2 a trade, Lennane says.

So in 2005, ex24 offered discount brokerage services to customers for $4 a trade, beating virtually all competitors. For example, Scottrade charges $7 a trade and TD Ameritrade charge $9.99.

With the brokerage in place, Lennane started advertising on the CNBC cable business-news channel, in newspapers in the northeast and on Web sites such as Google and Yahoo. Ex24 spends $500,000 a year for marketing, he says.

The advertising is starting to pay off, as new customers sign up in greater numbers. Link says customers come in two distinct groups. The first group is small investors who set up an account with $500 to $2,000. The second group of investors typically puts in $50,000. "We're getting our own customers," Lennane says.

Although the firm has about 2,000 customers now, Lennane is considering spending more money to grow the customer base to as many as 50,000. "If we break through, our incremental costs are zilch," Lennane says. That's because ex24's staff of seven people has automated the entire process on the Web site. "The accounting system took two years to set up," he says.

What's more, he doesn't need a huge staff of telephone reps because his customers are savvy Internet users. "Traditionally, those people don't even want to talk to you on the phone," he says.

In the meantime, ex24 is working on offering new products. One concept that will be released in January is the virtual exchange-traded fund (ETF). An ETF is a mutual fund that trades like a stock. Since a mutual fund is a basket of securities, ex24 will let customers build their own custom ETFs that they can then sell in whole or in part to other investors.

Once ex24 reaches the 50,000-customer mark, Lennane says he'll go back to pitch his company to the likes of Google and eBay. Why wouldn't they just bypass ex24 and build their own trading systems?

If Lennane's long and painful experience with federal regulators is any guide, they'd be better off with ex24.

How ex24 compares

Because ex24 can clear its own stock trades, the company can offer investors low online trade commissions. Ex24 charges $4 per trade when it acts as a broker and $2 per trade when customers buy or sell on its own trading system at ex24.com. Here's what other discount brokers charge for online-trade commissions:

•Bank of America charge $0 to $14 per share for trades depending on assets held at the bank.

•Charles Schwab charges $12.95 per trade and $9.95 for frequent traders or wealthier clients.

•ETrade charges $6.99 to $12.99 depending on the number of trades and assets held with the firm.

•Fidelity charges $8 to $19.95 depending on the number of trades and assets held with the firm.

•Muriel Siebert charges $14.95 per trade.

•Scottrade charges $7 per trade.

•Sharebuilder charges $4 per trade.

•TD Ameritrade charges $9.99 per trade.